What A Yield Curve Inversion Means For Traders

It has spread to the euro zone, where the German 2-10 yield curve is at its flattest since mid-2017 at 85.70 basis points.

Adding to worries over the outlook for the global economy, the yield curve between US three-year and five-year notes, and between two-year and five-year paper inverted on Monday - the first parts of the Treasury yield curve to invert since the financial crisis, excluding very short-dated debt.

The moves follow similar declines in USA bank shares (.SPSY), which dropped 4.4 percent on Tuesday [.N]. A year ago, the cushion was at 0.62 percentage points. The Australian dollar was down 0.5 percent at US$0.7304. Losses were led by a 1.6 percent decline in bank shares, which are being pummelled by the latest declines in long-dated government bond yields. US financial shares, which are particularly sensitive to bond market swings, dropped 4.4 percent.

According to the San Francisco Fed, each of the nine USA recessions that have occurred since 1955 came between six months and 24 months after a an inversion in the yield curve of two-year and 10-year Treasury yields.

Concerns about slowing US growth have accelerated the flattening of the yield curve, a phenomenon in which longer-dated debt yields fall faster than their shorter-dated counterparts.

"The market decline in the USA overnight and the flattening of the yield curve reflect that economic growth momentum is taking over as the primary concern for investors", Tai Hui, a strategist at J.P. Morgan Asset Management told clients. Inverted yield curves have historically occurred during periods of economic recession.

A flatter curve is seen as an indicator of a slowing economy, with lower longer-dated yields suggesting that the markets see economic weakness ahead.

The inverted yield curve persists for a second day. On Tuesday, the Dow Jones Industrial Average fell almost 800 points, or 3.1%, largely in response to recession fears stoked by recent changes in the yield curve.

"The U.S. economy is likely to be able to withstand another rate hike or two, therefore, the flattening of the Treasury curve looks a little over done".

Markets are also bracing for more news on the Brexit front.

Trump threatened on Tuesday to place "major tariffs" on Chinese goods imported into the United States if his administration is unable to reach an effective trade deal with Beijing.

Recessionary pressures could be exacerbated if fears surrounding the US-China trade war are resumed following a 90-day truce, agreed at the G20 in Argentina last week.

Failure would raise the spectre of fresh USA tariff action and potential Chinese retaliation as early as March.

It rose 0.2 percent to 113 yen (JPY=) after losing 0.75 percent the previous day against the safe-haven Japanese currency. "(European) equities closed on Tuesday only modestly lower while there were sharp falls in the U.S.", Martin van Vliet, senior rates strategist at ING, said.

USA crude futures were down 1.7 percent at US$52.35 per barrel and Brent shed 1.75 percent to US$61.00 per barrel.

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